India's FDI inflows: Has Singapore gained at the expense of Mauritius?

In the first three quarters of 2018-19, total FDI inflows at $46.62 billion fell by over 3% over the same period of 2017-18

The sheen of the Modi government’s performance in attracting foreign direct investment (FDI) to India has worn off considerably. Last year, i.e. 2017-18, total FDI inflows improved by just over 1.25 per cent over $60.22 billion recorded in 2016-17. In the current year, such inflows are expected to decline over those in the previous year. In the first three quarters of 2018-19, total FDI inflows at $46.62 billion fell by over 3 per cent over the same period of 2017-18. If this trend continues, the current year will see the first annual decline in FDI inflows during the five years of the Modi regime.

To be sure, the first two years of the Modi regime did see a healthy rise in FDI flows — by 25 per cent and 23 per cent, respectively, in 2014-15 and 2015-16. In the third year, the growth decelerated to just 8 per cent. That is why, perhaps, further deceleration in 2017-18 and a likely decline in 2018-19 will stand out in comparison.

Of course, this performance looks better than the Manmohan Singh government’s FDI show between 2009-10 and 2013-14. During the Singh government’s five years, FDI inflows fell in as many as three years — by 10 per cent in 2009-10, by 8 per cent in the following year and again by 26 per cent in 2012-13. There was a smart recovery of 34 per cent in 2011-12 and a 5 per cent pick-up in 2013-14. Thus, total FDI flows of $36 billion in the last year of the Singh government (2013-14) were even lower than the flows of $37.7 billion in its first year (2009-10).

The Modi government will certainly do better than that. But its FDI performance has a few other facets that need closer scrutiny. The services sector continues to attract the single largest amount of FDI equity. According to the government’s definition for FDI purposes, the services sector includes financial entities, banks, insurance services, business outsourcing, research and development activities, courier services, technology firms, and testing and analysis companies. After seeing a decline in 2017-18, the services sector has once again recovered with FDI equity flows of $6.59 billion in the first three quarters of 2018-19.

Computer software and hardware as a sector is the other steady performer. FDI equity inflows into this category are estimated at about $5 billion in the April-December 2018 period, compared to $6.15 billion in the whole of 2017-18. Trading and telecommunications have also continued to attract reasonably large FDI equity flows. Sectors that have done poorly in comparison include construction and pharmaceuticals.

The only manufacturing sector that continues to maintain steady performance is the automobile industry. At $2.1 billion in the first three quarters of 2018-19, this sector has already exceeded the total FDI equity inflows during the entire period of 2017-18, which in itself represented a 30 per cent increase over the previous year. It would thus appear that the automobile story in FDI equity inflows is very much intact.

However, there is no denying that it is the services sector and not manufacturing that continues to be the leading catalyst for dynamism in India’s FDI equity inflows. This has its obvious ramifications for the economy. As is to be expected, the services sector is generally more suitable for the skilled category of workers and may not facilitate easy migration or redeployment of a large number of agricultural workers, who are looking out for fresh opportunities outside the farm sector.

The latest numbers on FDI equity inflows reveal another interesting trend. Two of India’s biggest sources of FDI equity inflows are Mauritius and Singapore. Cumulatively, these two countries account for a little more than half of India’s entire FDI equity inflows in the last 18 years. This amounts to over $2.1 trillion in this period. Such large FDI equity flows have taken place mainly because of the kind of tax advantages, which investments from these two destinations used to enjoy, till recently. But these advantages began to be phased out from 2017 in an attempt to prevent tax evasion, curb revenue loss and streamline the flow of investments.

Thus, in August 2016, the Indian government notified a revised tax treaty with Mauritius, which in effect levied capital gains tax on investments routed through that country. From April 1, 2017, the capital gains tax on such investments from Mauritius was imposed at half of the prevailing domestic rate; and the full duty without any rebate will be imposed from April 1, 2019.

A few months later, in March 2017, the government notified a similar amendment to its tax treaty with Singapore. As a result of this change, all investments into India from Singapore began attracting capital gains tax at the source of such investments. In a bid to reduce the jolt to the system, the government also decided that from April 1, 2017, the capital gains tax would be levied at 50 per cent of the prevailing domestic rate and the full rate would be enforced from April 1, 2019.

Significantly, there was no measurable impact on FDI equity inflows from Singapore or Mauritius in 2017-18, the first year when the tax benefits were effectively cut by half. FDI equity inflows from Mauritius that year were estimated at about $16 billion, just about a per cent more than those in 2016-17. But Singapore showed a dramatic recovery and India’s FDI equity inflows from that country in 2017-18 rose by about 40 per cent to $12 billion.

The trend so far in the first three quarters of current year shows that India continues to see higher FDI equity inflows from Singapore ($13 billion), while the flows from Mauritius have taken a big hit, slowing down to just about $6 billion.

It seems that the impact of the new tax laws has been negligible on Singapore, but significantly adverse for Mauritius. Indeed, the flows from Singapore have increased. A clearer indication will be available from 2019-20, when the entire capital gains benefits for both the countries will be withdrawn from April 1, 2019. But a reasonable question that can be raised now is: Has Singapore gained at the expense of Mauritius?